24 November 2004 Internal T.I. 2004-0088061I7 - CGD-netting of gains and losses

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether capital losses on QSBC shares of an estate and deemed to be the losses of the deceased under ss. 164(6) must be netted against the deceased's capital gains on QSBC shares in the last taxation year for the purposes of par. 110.6(2.1)(d) of the Act.

Position: Yes.

Reasons: Reading of the Act.

		November 24, 2004

	John Cunningham	HEADQUARTERS
	Audit Services Section	P. Massicotte, CA, M.Fisc.
	Toronto North Tax Services Office	(613) 590-1116

		2004-008806

Capital Gains Deduction - Paragraph 110.6(2.1)(d) of the Income Tax Act ("Act")

This is in response to your enquiry of July 27, 2004, in which you request our comments in connection with the application of paragraph 110.6(2.1)(d) of the Act in a specific situation. The relevant facts, as we understand them, are as follows:

1. A taxpayer (Mr.X) was resident of Canada until he died in 2002. For last taxation year of Mr.X, taxable capital gains of $XXXXXXXXXX were determined under paragraph 3(b) of the Act before any elections were made pursuant to subsection 164(6) of the Act.

2. The amount of taxable capital gains for the year of death is comprised in part of taxable capital gains of $XXXXXXXXXX resulting from deemed disposition under subsection 70(5) of the Act of shares of a corporation ("A Co") which were considered "qualified small business corporation shares" ("QSBC shares"), as defined in subsection 110.6(1) of the Act. In addition, taxable capital gains of $XXXXXXXXXX resulted from the disposition or deemed disposition of properties other than QSBC shares. No allowable capital losses have resulted from the disposition or deemed disposition of capital properties of Mr.X in the year of death and Mr.X had no "qualified farm property", as defined in subsection 110.6(1) of the Act.

3. Pursuant to subsection 110.6(2.1) of the Act, Mr.X claimed a capital gains deduction of $XXXXXXXXXX in computing his taxable income for the year of death in connection with the taxable capital gains realised on the deemed disposition of the QSBC shares described above.

4. During the first taxation year of the estate of Mr.X, all his shares of A Co were redeemed, resulting in a deemed dividend of $XXXXXXXXXX for the estate, pursuant to subsection 84(3) of the Act, and a capital loss for the same amount (allowable capital loss of $XXXXXXXXXX). The estate's capital loss was not subject to the provisions of subsections 40(3.6) or 112(3.2) of the Act, and was not a business investment loss under paragraph 39(1)(c) of the Act.

5. The legal representatives of Mr.X have elected under paragraph 164(6)(c) of the Act, in a prescribed manner and within a prescibed time, for the entire capital loss resulting from the redemption of the shares of A Co to be deemed a capital loss of Mr.X from the disposition by him of the shares of A Co during his last taxation year.

6. The final tax return of Mr.X was amended pursuant to paragraph 164(6)(e) of the Act to revise the amount determined under paragraph 3(b) of the Act for the year of death. The amount determined under paragraph 3(b) of the Act for the 2002 taxation year of Mr.X was therefore reduced to $XXXXXXXXXX ($XXXXXXXXXX - $XXXXXXXXXX).

7. The legal representatives of Mr.X however have not reduced the capital gains deduction claimed, pursuant to subsection 110.6(2.1) of the Act, by Mr.X for the 2002 taxation year.

You ask whether the capital loss resulting from the redemption of the shares of A Co, and deemed to be the capital loss of Mr.X for the year of death pursuant to paragraph 164(6)(c) of the Act, will affect the amount determined under paragraph 110.6(2.1)(d) of the Act in connection with the capital gains deduction which Mr.X may claim in the year of death. More specifically, you ask whether the capital gains and capital losses on QSBC shares must be "netted" when determining the amount of a capital gains deduction under paragraph 110.6(2.1) of the Act.

The legal representatives of Mr.X submit that the capital loss on the shares of A Co in the situation described above should not have the effect of reducing the amount determined under paragraph 110.6(2.1)(d) of the Act for the 2002 taxation year of Mr.X.

Our Comments

Subsection 110.6(2.1) of the Act provides that, in computing the taxable income for a taxation year of an individual (other than a trust) who was resident in Canada throughout the year and who disposed of a share of a corporation in the year that was a QSBC share of the individual, an amount may be deducted not exceeding the least of the amounts determined under paragraphs 110.6(2.1)(a) to (d) of the Act.

The amount determined under paragraph 110.6(2.1)(d) of the Act represents the amount that would be determined for the year under paragraph 3(b) of the Act (other than an amount included in determining the amount in respect of the individual under paragraph 110.6(2)(d) of the Act) in respect of capital gains and capital losses of the individual if the only properties referred to in paragraph 3(b) were QSBC shares disposed of by the individual. This amount therefore represents the net taxable capital gains for the year from the disposition of QSBC shares, that is, the excess of taxable capital gains over allowable capital losses for the year resulting from the disposition of QSBC shares.

Where the estate of a taxpayer has capital losses in its first taxation year from the disposition of properties, the legal representative of the deceased taxpayer may elect pursuant to subsection

164(6) of the Act to have a portion or all of these losses deemed to be capital losses of the deceased taxpayer for the year in which the taxpayer died, and not be capital losses of the estate.

In our view, where such an election is made in respect of capital losses resulting from the disposition of properties that were QSBC shares of the estate, these losses will be considered capital losses of the deceased from the disposition of QSBC shares in the year in which the taxpayer died. As a result, such capital losses will reduce (to the extent provided in subparagraph 3(b)(ii) of the Act) the net taxable capital gain that would be determined under paragraph 3(b) of the Act if the only properties disposed of during the year in which the taxpayer died were QSBC shares, and will therefore reduce the amount determined under paragraph 110.6(2.1)(d) of the Act for the year.

In the situation described above, if the shares of A Co were QSBC shares of the estate at the time they were redeemed, it is our opinion that the amount determined under paragraph 110.6(2.1)(d) of the Act for the 2002 taxation year of Mr.X would be nil; that is, the amount by which the total of taxable capital gains from the disposition of QSBC shares in the year, determined under subparagraph 3(b)(i) of the Act ($XXXXXXXXXX), exceeds the total of allowable capital losses, deemed to have been realised by Mr.X pursuant to paragraph 164(6)(c) of the Act from the disposition of QSBC shares in the year, determined under subparagraph 3(b)(ii) of the Act ($XXXXXXXXXX). Accordingly, in this situation, Mr.X would no longer be entitled to claim the capital gains deduction for the year of death.

However, if the shares of A Co were not QSBC shares of the estate at the time they were redeemed, we would agree with the taxpayer's representatives that, in this case, the capital gains deduction of $XXXXXXXXXX initially claimed by Mr.X for the 2002 taxation year would not be denied by the application of paragraph 110.6(2.1)(d) of the Act, notwithstanding the election made under subsection 164(6) of the Act. This is because, although an allowable capital loss of $XXXXXXXXXX is determined under subparagraph 3(b)(ii) of the Act for Mr.X's year of death, the loss cannot be considered to have resulted from the disposition of QSBC shares. Moreover, the "annual gains limit", as defined in subsection 110.6(1) of the Act, and referred to in paragraph 110.6(2.1)(c) of the Act, in this case would not be less than the amount determined under paragraph 110.6(2.1)(d) of the Act, as the net taxable capital gains for the year determined under paragraph 3(b) of the Act ($XXXXXXXXXX) would be greater than the net taxable capital gains from the disposition of QSBC shares for the year ($XXXXXXXXXX). We assume that the limits in paragraphs 110.6(2.1)(a) and (b) of the Act are not an issue in this case.

We trust you will find the above to be of assistance. If you have any questions regarding the above, please do not hesitate to contact us.

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate